NIESR says a return to recession, technically defined as two consecutive quarters of contraction, would be driven by squeezed families cutting back further, tight credit conditions and businesses’ reluctance to invest amid uncertainty over domestic and foreign demand.

The thinktank is forecasting a significant rebound in 2013, with growth of 2.3%, but NIESR’s Simon Kirby said the outlook was very hard to call. “That the economy is in poor shape is obvious. The degree to which this persists is uncertain,” he said.

NIESR urging the government to loosen its fiscal stance and shore up faltering demand. It argues the government could easily afford to invest enough money, for example in infrastructure projects such as road-building, to avert recession this year without denting its credibility in financial markets or doing any long-term damage to the public finances.

Jonathan Portes, the NIESR’s director, said not wavering from the government’s path was “accepting a significant degree of long-term economic and social damage” and that investing to boost demand was as much about creating jobs as boosting growth. “It’s not primarily about bigger growth next year. It’s about the long-run economic and social damage … that we are deliberately doing,” he said.

UK unemployment at 8.4% is at its highest since 1995. NIESR predicts a peak of 9.1% in late 2012 and averaging 8.9% over the year, equivalent to some 3 million people.

That forecast for lengthening dole queues is accompanied by predictions of a slight rise in net trade, but merely because of a drop in imports from a faltering economy rather than any upturn in exports. Consumer spending is expected to make a slight contribution to the overall economy, however, as easing inflation boosts families’ disposable incomes.

Adam Posen, a Bank of England policymaker, warned separately that the central bank may need to pump more electronic money into the economy if the outlook remained depressed. He argued that quantitative easing had helped the recovery and that he was prepared to vote for more if it became clear the UK economy was entering another recession.

At a conference organised by the TUC to discuss the future of banking, Posen also raised concerns about credit constraints on businesses. He had put forward plans last year for a new agency or bank to offer credit to small and medium-sized businesses, which was endorsed in principle by the chancellor, George Osborne. But yesterday he said he was disappointed that the momentum behind the proposal, which aimed to kickstart growth among smaller companies, had dissipated in recent months.

NIESR shares the view of most economists that there is more QE to come against the backdrop of what it sees as a virtually flat economy in 2012. That economic outlook is a stark downgrade from the thinktank’s October forecast for 0.8% growth, which was based on the assumption that the eurozone debt crisis would be resolved sooner rather than later. At the time it also published a 0.2% growth forecast based on a scenario in which eurozone policymakers “muddle” through the crisis through much of 2012.

It now sees such a “muddle through” scenario as more likely and forecasts recession for the eurozone, with contraction there of 0.2% this year. That assumes a “delayed but ultimately successful resolution” to the crisis. But there are upside and downside risks to that forecast, NIESR’s economists stressed, notably that a disorderly breakup of the euro would likely lead to a “considerably more severe downturn”.

For the wider world economy NIESR predicts relatively modest growth of 3.5% in 2012, with the US and Canada enjoying slightly stronger prospects than Europe and Japanese growth being supported by post-earthquake reconstruction projects.